FOR THE YEAR ENDED DECEMBER 31, 2017

Transcription

1 FOR THE YEAR ENDED DECEMBER 31, 2017

2 KPMG LLP 205 5th Avenue SW Suite 3100 Calgary AB T2P 4B9 Telephone (403) Fax (403) To the Shareholders of PrairieSky Royalty Ltd. INDEPENDENT AUDITORS REPORT We have audited the accompanying consolidated financial statements of PrairieSky Royalty Ltd., which comprise the consolidated statements of financial position as at December 31, 2017 and December 31, 2016, the consolidated statements of earnings and comprehensive income, changes in shareholders equity and cash flows for the years then ended, and notes, comprising a summary of significant accounting policies and other explanatory information. Management s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the entity s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of PrairieSky Royalty Ltd. as at December 31, 2017 and December 31, 2016, and its consolidated financial performance and its consolidated cash flows for the years then ended in accordance with International Financial Reporting Standards. Chartered Professional Accountants February 26, 2018 Calgary, Canada KPMG LLP is a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. KPMG Canada provides services to KPMG LLP.

3 CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (millions) December 31, 2017 December 31, 2016 Assets Current Assets Cash and cash equivalents $ 45.1 $ 34.0 Accounts receivable and accrued revenue (Note 4) Prepaids Royalty assets, net (Note 6) Exploration and evaluation assets (Note 7) 1, ,185.5 Deposit (Note 7) Royalty note receivable Goodwill (Note 8) Total Assets $ 2,971.7 $ 2,770.3 Liabilities and Shareholders Equity Current Liabilities Accounts payable and accrued liabilities (Note 9) $ 17.0 $ 19.4 Income tax payable (Note 14) Dividend payable (Note 10) Share-based compensation payable (Note 11) Deferred income taxes (Note 14) Total Liabilities Shareholders Equity Shareholders capital (Note 10) 3, ,071.2 Paid in surplus Deficit (617.1) (539.1) Total Shareholders Equity 2, ,535.0 Commitments (Note 18) Total Liabilities and Shareholders Equity $ 2,971.7 $ 2,770.3 See accompanying Notes to Consolidated Financial Statements. Approved on behalf of the Board of Directors of PrairieSky Royalty Ltd.: (signed) James M. Estey Director (signed) Margaret A. McKenzie Director PrairieSky Royalty Ltd

4 CONSOLIDATED STATEMENTS OF EARNINGS AND COMPREHENSIVE INCOME For the year ended December 31 (millions, except per share amounts) Revenues Royalty revenue $ $ Other revenue (Note 12) Revenues Expenses Production and mineral taxes Depreciation, depletion and amortization (Note 6) Exploration and evaluation (Note 7) Administrative (Note 13) Net Earnings Before Finance Items and Income Taxes Finance Items Finance income (1.3) (2.1) Finance expense Net Earnings Before Income Taxes Income tax expense (recovery) (Note 14) 18.5 (0.5) Net Earnings and Comprehensive Income $ $ 20.0 Net Earnings per Common Share Basic and Diluted (Note 10) $ 0.51 $ 0.09 See accompanying Notes to Consolidated Financial Statements. PrairieSky Royalty Ltd

5 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY (millions) Shareholders Capital Paid In Surplus Deficit Total Shareholders Equity Balance at December 31, 2016 $ 3,071.2 $ 2.9 $ (539.1) $ 2,535.0 Net earnings Common shares issued: Pursuant to bought deal offering (Note 10) Share issue costs, net of tax (Note 10) (8.8) - - (8.8) Pursuant to stock option plan (Note 10) 1.2 (1.9) - (0.7) Pursuant to acquisition (Note 7) Common shares repurchased (Note 10) (19.8) - (22.4) (42.2) Share-based compensation (Note 11) Dividends on common shares (Note 10) - - (176.2) (176.2) Balance at December 31, 2017 $ 3,334.3 $ 2.8 $ (617.1) $ 2,720.0 (millions) Shareholders Capital Paid In Surplus Deficit Total Shareholders Equity Balance at December 31, 2015 $ 3,067.8 $ 1.8 $ (359.4) $ 2,710.2 Net earnings Common shares issued: Pursuant to dividend reinvestment plan (Note 10) Pursuant to stock dividend plan (Note 10) Share issue costs, net of tax (Note 10) Pursuant to stock option plan (Note 10) 0.1 (0.1) - Common shares repurchased (Note 10) (13.0) - (13.0) (26.0) Share-based compensation (Note 11) Dividends on common shares (Note 10) - - (186.7) (186.7) Balance at December 31, 2016 $ 3,071.2 $ 2.9 $ (539.1) $ 2,535.0 See accompanying Notes to Consolidated Financial Statements. PrairieSky Royalty Ltd

6 CONSOLIDATED STATEMENTS OF CASH FLOWS For the year ended December 31 (millions) Operating Activities Net earnings $ $ 20.0 Depreciation, depletion and amortization (Note 6) Exploration and evaluation (Note 7) Deferred income taxes (Note 14) 6.9 (0.5) Share-based compensation, net of cash settlements (Note 11) Other non-cash items (Note 6,7) (16.2) (0.2) Net change in other assets Funds from operations Net change in non-cash working capital (Note 17) Cash From Operating Activities Investing Activities Royalty asset acquisitions (Note 6) (55.7) (45.0) Exploration and evaluation acquisitions (Note 7) (305.4) (51.2) Royalty business combination (Note 5) - (42.2) Reclassification of deposit to asset acquisition (deposit) (Note 7) 15.0 (15.0) Net change in non-cash working capital (Note 17) (0.2) (0.4) Cash Used in Investing Activities (346.3) (153.8) Financing Activities Dividends on common shares (Note 10) (175.2) (181.5) Share issuance, net of costs (Note 10) Stock option exercise (Note 11) (0.7) - Common shares repurchased (Note 10) (42.2) (26.0) Net change in non-cash working capital (Note 17) - (0.3) Cash From (Used in) Financing Activities 58.8 (207.6) Increase (Decrease) in Cash and Cash Equivalents 11.1 (156.8) Cash and Cash Equivalents, Beginning of Year Cash and Cash Equivalents, End of Year $ 45.1 $ 34.0 See accompanying Notes to Consolidated Financial Statements. PrairieSky Royalty Ltd

7 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1. NATURE OF OPERATIONS PrairieSky Royalty Ltd. ( PrairieSky or the Company ) has a geologically and geographically diverse portfolio of fee simple mineral title, crude oil and natural gas gross overriding royalty interests and other acreage spanning Alberta, Saskatchewan, British Columbia and Manitoba (collectively, the Royalty Properties ). The Company is focused on encouraging third parties to actively develop the Royalty Properties, while strategically seeking additional petroleum and natural gas royalty assets that provide the Company with medium-term to long-term value enhancement potential. The Company does not directly conduct operations to explore for, develop or produce petroleum or natural gas; rather, third party development of the titled or leased lands provides the Company with royalty revenue as petroleum and natural gas are produced from such properties. The Company s shares are publicly traded on the Toronto Stock Exchange ( TSX ) under the stock symbol PSK. The location of the head and registered office of the Company is Suite 1700, th Avenue S.W., Calgary, Alberta, T2P 3N9. 2. BASIS OF PRESENTATION These consolidated financial statements (the financial statements ) have been prepared in accordance with International Financial Reporting Standards ( IFRS ) as issued by the International Accounting Standards Board ( IASB ). These financial statements have been prepared on a historical cost basis, except for share-based payment transactions. The financial statements have been prepared on a going concern basis and amounts are in millions of Canadian dollars unless otherwise stated. These financial statements were approved and authorized for issuance by the Company s Board of Directors on February 26, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A) SIGNIFICANT ACCOUNTING ESTIMATES AND JUDGMENTS The timely preparation of financial statements requires management to make estimates and use judgment regarding the reported amounts of assets and liabilities, revenues and expenses and disclosures of contingent assets and liabilities as at the date of the financial statements. Such estimates primarily relate to fair value estimates and unsettled transactions and events as at the date of the financial statements and accordingly, actual results could differ from the estimates. Significant estimates and judgments made by management in the preparation of these financial statements are outlined below. Identification of Cash Generating Units The identification of cash generating units ( CGUs ) requires judgment. CGUs are defined as the lowest level of integrated assets for which there are separately identifiable cash flows that are largely independent of cash flows from other assets or groups of assets. The classification of assets and allocation of corporate assets into CGUs requires judgment and interpretation. Factors considered in the classification include how management monitors the entity s operations, how management makes decisions about continuing or disposing of assets and operations, and the nature of the assets. PrairieSky Royalty Ltd

8 Crude Oil and Natural Gas Reserves Reserves estimates are not recorded in the Company s financial statements but they do affect net earnings and assets and liabilities through their impact on depreciation, depletion and amortization ( DD&A ), amounts used for impairment calculations, deferred taxes and amounts used to determine fair values of assets acquired through acquisitions and business combinations. By their nature, the estimates of reserves, including the estimates of future prices, costs, discount rates and the related future cash flows, are subject to measurement uncertainty. Accordingly, the impact to amounts reported in the financial statements for future periods could be material. Reserves have been evaluated at December 31, 2017 by the Company s independent qualified reserves evaluators. Recoverability of Asset Carrying Values Judgments are required to assess when impairment indicators, or reversal indicators, exist and impairment testing is required with respect to the carrying value of long-lived assets and goodwill. Refer to Note 3(H) and 3(I). The application of the Company s accounting policy to transfer assets from exploration and evaluation to royalty assets or to expense capitalized exploration and evaluation assets requires management to make certain judgments based on the estimated proved and probable reserves used in the determination of an area's technical feasibility and commercial viability. Business Combinations Management s judgement is required to determine whether a transaction constitutes a business combination or asset acquisition. This judgement is based on the criteria in IFRS 3, Business Combinations. Business combinations are accounted for using the acquisition method of accounting and are differentiated from an asset acquisition when business processes are associated with the assets. Refer to Note 3(L) regarding estimation uncertainty with respect to fair values assigned in a business combination. Oil and Natural Gas Revenue Accruals The Company follows the accrual method of accounting, making estimates in its financial and operating results. This may include estimates of production, royalty revenue and related expenses for the period reported, for which actual results have not yet been received. The Company has no operational control over the Royalty Properties and as a result, the Company uses historical production information to estimate revenue accruals. These accrual estimates are revised based on the receipt of actual production results. Share-based Compensation The calculation of share-based compensation includes both judgments and estimates. Judgments include which valuation model is most appropriate to estimate the fair value of awards granted under the Company s Stock Option Plan, as well as the determination of the peer group used to calculate the total shareholder return under the Performance Share Unit ( PSU ) Plan. Refer to Note 3(O). Under the Stock Option Plan, the Company uses the Black-Scholes option pricing model which requires that management make estimates for the expected life of the option, the anticipated volatility of the share price over the life of the option, the dividend yield, the risk-free interest rate for the life of the option, and the number of options that will ultimately vest. Estimates of forfeiture rates are made through the vesting period for the Company s various long-term incentive plans. Estimates are based on past forfeitures and future expectations and are adjusted for actual forfeitures when stock options or units are exercised. Estimates and assumptions are then used in the valuation model to determine the fair value, including the number of share unit awards that will ultimately vest for both the PSU Plan and the Restricted Share Unit ( RSU ) Plan. Fluctuations in share-based compensation may occur due to changes in the underlying share PrairieSky Royalty Ltd

9 price or revised management estimates of relevant performance factors under the Company s PSU Plan. Estimates of the total shareholder return for PSUs are made each period end. Income Taxes Tax provisions are based on enacted or substantively enacted laws. Changes in those laws could affect amounts recognized in the period of change and future periods. Deferred income tax assets are recognized to the extent future recovery is probable in management s judgment. Deferred income tax assets are reduced to the extent that it is no longer probable that sufficient taxable earnings will be available to allow all or part of the asset to be recovered. B) FUNCTIONAL AND PRESENTATION CURRENCY These financial statements are presented in Canadian dollars, which is the functional currency of PrairieSky. C) PRINCIPLES OF CONSOLIDATION The financial statements include the accounts of the Company and all of its subsidiary companies. Subsidiaries are all entities over which the Company has control. Subsidiaries are consolidated from the date on which the Company obtains control. They are deconsolidated from the date that control ceases. Control exists when the Company has the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. All intercompany balances and transactions, and any unrealized income and expenses, arising from intercompany transactions are eliminated in full. D) CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand and short-term investments, such as money market deposits or similar type instruments, with a maturity of three months or less when purchased. E) EXPLORATION AND EVALUATION Exploration and evaluation ( E&E ) assets consist of expenditures incurred in an exploration area pending the determination of technical feasibility and commercial viability. These costs include unproved property acquisition costs, undeveloped land, mineral leases, seismic, and the carrying value of E&E assets acquired from Encana Corporation ( Encana ) on May 27, Assets classified as E&E are not amortized or depleted. Technical feasibility and commercial viability is considered to be determinable when proved and probable reserves are determined to exist and are capable of economic production. When an area is determined to be technically feasible and commercially viable, the accumulated costs are transferred to royalty assets. E&E assets are assessed for impairment prior to any such transfer. When an area is determined not to be technically feasible and commercially viable, the unrecoverable costs are charged to net earnings as E&E expense. F) ROYALTY ASSETS Royalty assets are measured at cost less accumulated depletion, depreciation and amortization. All costs directly associated with fee simple lands and royalty interests are capitalized on an area-by-area basis. Costs include acquisitions of royalty interests with proved or probable reserves, transfers of exploration and evaluation assets and the carrying value of royalty assets acquired from Encana. Costs accumulated within each area are depleted using the unit-of-production method based on proved plus probable reserves using estimated future prices and costs. PrairieSky Royalty Ltd

10 For divestitures of properties, a gain or loss is recognized in net earnings. Exchanges of properties are measured at fair value, unless the transaction lacks commercial substance or fair value cannot be reliably measured. Where the exchange is measured at fair value, a gain or loss is recognized in net earnings. Costs associated with office furniture, fixtures, leasehold improvements and information technology are carried at cost and depreciated on a straight-line basis over the estimated service lives of the assets, which range from three to 10 years. G) BUSINESS COMBINATIONS Business combinations within the scope of IFRS 3 are accounted for using the acquisition method. The acquired identifiable net assets are measured at their fair value at the date of acquisition. Deferred taxes are recognized for any differences between the fair value and the tax basis of net assets acquired. Any excess of the purchase price over the fair value of the net assets acquired is recognized as goodwill. Any deficiency of the purchase price below the fair value of the net assets acquired is recorded as a gain in net earnings. Associated transaction costs are expensed when incurred. When a business combination includes a non-controlling interest, the non-controlling interest is initially measured based on either its fair value or its proportionate share of the fair value of identifiable net assets acquired. In connection with the acquired royalty business from Encana on May 27, 2014, the Company was a wholly owned subsidiary and controlled by Encana prior to closing the Initial Public Offering ( IPO ), and immediately subsequent to closing. Business combinations involving entities under common control are outside the scope of IFRS 3 Business Combinations. IFRS provides no guidance on the accounting for these types of transactions. As a result, the Company was required to develop an accounting policy. The three most common methods utilized are the purchase method, the predecessor values since inception method, and the predecessor values from date of transaction method. Management determined that the predecessor values from date of transaction method to be the most appropriate. This method requires the financial statements to be prepared using the predecessor carrying values without an adjustment to fair value. The difference between any consideration given and the aggregate carrying value of the assets and liabilities acquired, was recorded as a reserve from common control in shareholders equity and collapsed into retained earnings in H) IMPAIRMENT OF LONG-TERM ASSETS The carrying value of long-term assets, excluding goodwill, is reviewed at each reporting date for indicators that the carrying value of an asset or CGU may not be recoverable. E&E assets are also reviewed for impairment indicators and assessed for impairment upon reclassification from E&E assets to royalty assets. If indicators of impairment exist, the recoverable amount of the asset or CGU is estimated. If the carrying value of the asset or CGU exceeds the recoverable amount, the asset or CGU is written down with an impairment recognized in net earnings. A CGU is the lowest level at which there are identifiable cash inflows that are largely independent of the cash inflows of other CGUs. Based on the interdependency of the cash flows, costs capitalized in areas within royalty assets and E&E assets are aggregated into one CGU. The recoverable amount of an asset or CGU is the greater of its fair value less costs of disposal or its value in use. Fair value less costs of disposal is the amount obtainable from the sale of assets in an arm s length transaction less costs of disposal. Value in use is determined by estimating the present value of the future net cash flows expected to be derived from the continued use of the CGU. Reversals of impairments are recognized when there has been a subsequent increase in the recoverable amount. In this event, the carrying amount of the asset or CGU is increased to its revised recoverable amount with an impairment reversal recognized in net earnings. The recoverable amount is limited to the original carrying amount less accumulated depletion as if no impairment had been recognized for the asset or CGU for prior periods. PrairieSky Royalty Ltd

11 I) GOODWILL Goodwill represents the excess of consideration paid over the fair value of acquired assets and assumed liabilities recognized in a business combination. Subsequent measurement of goodwill is at cost less any accumulated impairments. Goodwill is assessed for impairment at least annually. If the carrying amount for the CGU exceeds the recoverable amount of the CGU, including goodwill, the associated goodwill is written down with an impairment recognized in net earnings. The recoverable amounts are determined based on the greater of fair value less costs of disposal or value in use. Fair value less costs of disposal is the amount obtainable from the sale of assets in an arm s length transaction less costs of disposal. Value in use is determined by estimating the present value of the future net cash flows expected to be derived from the continued use of the CGU. Goodwill impairments are not reversed. J) PROVISIONS AND CONTINGENCIES Provisions are recognized when the Company has a present obligation as a result of a past event, it is probable that an outflow of resources will be required and a reliable estimate can be made of the amount of the obligation. Provisions are measured based on the discounted expected future cash outflows. When a contingency is substantiated by confirming events, can be reliably measured and will likely result in an economic outflow, a liability is recognized in the financial statements as the best estimate required to settle the obligation. A contingent liability is disclosed where the existence of an obligation will only be confirmed by future events, or where the amount of a present obligation cannot be measured reliably or will likely not result in an economic outflow. Contingent assets are only disclosed when the inflow of economic benefits is probable. When the economic benefit becomes virtually certain, the asset is no longer contingent and is recognized in the financial statements. K) FINANCIAL INSTRUMENTS Financial instruments are measured at fair value on initial recognition of the instrument. Measurement in subsequent periods depends on whether the financial instrument has been classified as "fair value through profit or loss", "loans and receivables", "available-for-sale", "held-to-maturity", or "other financial liabilities" as defined by the accounting standard. Financial assets and financial liabilities at "fair value through profit or loss" are either classified as "held for trading" or "designated at fair value through profit or loss" and are measured at fair value with changes in those fair values recognized in net earnings. Financial assets classified as "loans and receivables", "heldto-maturity", and "other financial liabilities" are measured at amortized cost using the effective interest method of amortization. Financial assets classified as available-for-sale are measured at fair value, with changes in fair value recognized in other comprehensive income. Accounts receivable, accrued revenue, and royalty note receivable are classified as "loans and receivables" and are measured at amortized cost. Accounts payable and accrued liabilities and dividends payable are classified as "other financial liabilities" and are measured at amortized cost. The Company has not designated any financial instruments as "available-for-sale", "held-to-maturity" or "fair value through profit and loss". L) FAIR VALUE MEASUREMENTS The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. PrairieSky Royalty Ltd

12 A number of the Company s accounting policies and disclosures require the determination of fair value, for both financial and non-financial assets and liabilities. Fair values have been determined for measurement and/or disclosure purposes based on the following methods. When applicable, further information about the assumptions made in determining fair values is disclosed in the notes specific to that asset or liability. The fair value of royalty assets recognized in a business combination is based on market values. The market value of royalty assets is the estimated amount for which royalty assets could be exchanged on the acquisition date between a willing buyer and a willing seller in an arm s length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and with compulsion. The market value of royalty assets are estimated with reference to the cash flow multiples from production based on cash flow multiples of the same or similar assets, or are based on estimates of the reserves acquired. The market value of E&E assets are estimated with reference to the market values of current arm s length transactions in comparable locations. The assumptions and estimates with respect to determining the fair value of royalty and E&E assets in a business combination generally include estimates of reserves acquired, forecast benchmark commodity prices, and discount rates. Changes in any of the assumptions or estimates used in determining the fair value of acquired assets and liabilities could impact the amounts assigned to assets, liabilities and goodwill. Future net earnings can be affected as a result of changes in future DD&A, asset impairment or goodwill impairment. M) REVENUE RECOGNITION Royalty revenue on the sale of crude oil, natural gas liquids ( NGL ) and natural gas is recognized when the product is produced. Revenue for royalty production that is taken in kind is recognized when the significant risks and rewards of ownership of the product are transferred to the buyer, which is usually when legal title is transferred to the external party. Revenue is measured at fair value of the consideration received or receivable when management can reliably estimate the amount, pursuant to the terms of the lease agreements. Differences between estimates and actual amounts are adjusted and recorded in the period that the actual amounts are received. Other revenue is comprised of all non-product related revenue streams, including revenue generated from lease rentals, bonus consideration received when new leases are negotiated and penalty payments for non-performance under required lease conditions. Revenue from each of these streams is recognized when the consideration is received or collection is certain. N) PRODUCTION AND MINERAL TAXES Production and mineral taxes relate to payments made to provincial governments based on acreage or production of crude oil and natural gas on non-government owned lands which is recognized when the product is produced. O) SHARE-BASED COMPENSATION The Company s long-term incentive plans include a Stock Option Plan and share unit award plans (RSU Plan, PSU Plan, and a Deferred Share Unit ( DSU ) Plan). Obligations for payments of cash or common shares under the Company s long-term incentive plans are accrued over the vesting period using fair values. For the equity-settled Stock Option Plan, fair values are determined at the grant date and are recognized over the vesting period as compensation costs with a corresponding increase to paid in surplus. When the awards are exercised, the associated paid in surplus is recognized in shareholders capital. The assumptions used by the Company are discussed in Note 11. For share unit awards, fair values are determined at grant date and subsequently revalued at each reporting date based on the market value of the Company s common shares and are recognized over the vesting period as compensation costs, with a corresponding change to liabilities. The valuation incorporates the PrairieSky Royalty Ltd

13 period-end share price, dividends declared during the period, the number of units outstanding at each period end and certain management estimates, such as estimated forfeiture rates and a performance multiplier for PSUs. Classification of the associated short-term and long-term liabilities is dependent on the expected payout dates. P) INCOME TAXES Income tax is recognized in net earnings except for items directly related to shareholders equity, in which case it is recognized in shareholders capital or other comprehensive income. Current income taxes are measured at the amount expected to be recoverable from or payable to the taxation authorities based on the income tax rates enacted or substantively enacted at the end of the reporting period. The Company follows the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recorded for the effect of any temporary difference between the accounting and income tax basis of an asset or liability. Deferred income tax assets are recognized to the extent future recovery is probable. Deferred income tax assets are reduced to the extent that it is no longer probable that sufficient taxable earnings will be available to allow all or part of the asset to be recovered. Deferred income tax is calculated using the enacted or substantively enacted income tax rates expected to apply when the assets are realized or liabilities are settled. The effect of a change in the enacted or substantively enacted tax rates is recognized in net earnings or in shareholders capital depending on the item to which the adjustment relates. Deferred income tax liabilities and assets are not recognized for temporary differences arising on: the initial recognition of goodwill; or the initial recognition of an asset or liability in a transaction which is not a business combination and, at the time of the transaction, affects neither accounting net earnings nor taxable earnings. Q) EARNINGS PER SHARE AMOUNTS Basic net earnings per common share is computed by dividing net earnings by the weighted average number of common shares outstanding during the period. Diluted net earnings per common share is calculated giving effect to the potential dilution that would occur if stock options were exercised or other contracts to issue common shares were exercised, fully vested, or converted to common shares. The treasury stock method is used to determine the dilutive effect of stock options and other dilutive instruments. The treasury stock method assumes that proceeds received from the exercise of in-the-money stock options and other dilutive instruments are used to repurchase common shares at the average market price for the period. R) RECENT ACCOUNTING PRONOUNCEMENTS New Standards Issued Not Yet Adopted On April 26, 2016, the International Accounting Standards Board ( IASB ) issued its final amendments to IFRS 15, Revenue from Contracts with Customers, which replaces IAS 18 Revenue, IAS 11 Construction Contracts and related interpretations. IFRS 15 provides a single, principles-based five-step model to be applied to all contracts with customers. The standard requires an entity to recognize revenue to reflect the transfer of goods and services for the amount it expects to receive, when control is transferred to the purchaser. Disclosure requirements have also been expanded. The standard is required to be adopted either retrospectively or by recognizing the cumulative effect of initially applying IFRS 15 as an adjustment to opening equity at the date of initial application for annual periods beginning on or after January 1, 2018, with earlier adoption permitted. The Company will adopt IFRS 15 in its financial statements PrairieSky Royalty Ltd

14 for the annual period beginning on January 1, 2018, using the modified retrospective adoption approach. The Company has completed its review of the various revenue streams and underlying contracts with customers and concluded that the adoption of IFRS 15 will not have a material effect on its financial statements. The Company will expand the disclosures in the notes to its financial statements as prescribed by IFRS 15 commencing in the first quarter of 2018, including disclosing the Company s disaggregated revenue streams by product type which have historically been disclosed in the Company s Management Discussion and Analysis. On July 24, 2014, the IASB issued IFRS 9, Financial Instruments, which replaces IAS 39, Financial Instruments: Recognition and Measurement. The new standard introduces new requirements for the classification and measurement of financial assets and liabilities. Financial assets are classified and measured based on the business model in which they are held and the characteristics of their contractual cash flows. IFRS 9 amends the impairment model by introducing a new model for calculating impairment and includes a new hedge accounting model that better reflects risk management activities in the financial statements of entities that elect to apply hedge accounting. IFRS 9 will apply retrospectively, for annual periods beginning on or after January 1, 2018 and early adoption is permitted. The Company will adopt IFRS 9 in its financial statements for the annual period beginning on January 1, The Company has concluded the standard will not have a material impact on the Company s financial statements. On January 13, 2016, the IASB issued IFRS 16, Leases. The standard is required to be adopted either retrospectively or by recognizing the cumulative effect of initially applying IFRS 16 as an adjustment to opening equity at the date of initial application. IFRS 16 is effective for fiscal years beginning on or after January 1, 2019, with earlier adoption permitted if IFRS 15 Revenue from Contracts with Customers has also been adopted. Under the new standard, companies will recognize new assets and liabilities, bringing off-balance sheet leasing arrangements onto the balance sheet. The Company s mineral leases are not within the scope of IFRS 16. The Company intends to adopt IFRS 16 in its financial statements for the annual period beginning on January 1, The Company does not expect the standard to have a material impact on the financial statements. 4. ACCOUNTS RECEIVABLE AND ACCRUED REVENUE December 31, 2017 December 31, 2016 Trade receivables and accrued revenue $ 39.0 $ 38.7 Current portion of royalty note receivable Interest receivable $ 43.0 $ 42.5 Trade receivables and accrued revenue relate to lease and royalty production payments receivable. At December 31, 2017, the Company had a royalty note receivable of $3.9 million outstanding (December 31, $3.7 million) which is receivable in equal monthly instalments over the next year bearing interest of four percent per annum. The analysis of accounts receivable and accrued revenue that are past due but not impaired is as follows: Neither past due nor Past due but not impaired Total impaired 4-6 Months 7-12 Months December 31, 2017 $ 43.0 $ 42.9 $ - $ 0.1 December 31, 2016 $ 42.5 $ 42.3 $ 0.1 $ 0.1 At December 31, 2017, there was no allowance or provision made for doubtful accounts. In determining the recoverability of trade receivables that are past due but not impaired, the Company considers the age of the outstanding receivables and the credit worthiness of the counterparties. See Note 16 for further information about credit risk. PrairieSky Royalty Ltd

15 5. BUSINESS COMBINATION On November 17, 2016, the Company completed a corporate acquisition of a private company (the 2016 Corporate Acquisition ) for cash consideration of $54.0 million, before closing adjustments. The following table summarizes the net assets acquired and liabilities assumed. Consideration: Cash consideration $ 54.0 Closing adjustments 0.1 Total consideration $ 54.1 Net Assets Acquired: Royalty assets $ 20.6 Exploration and evaluation assets 27.8 Goodwill 17.8 Working capital items 0.4 Deferred income taxes (12.5) Net assets acquired $ 54.1 The value attributed to the royalty assets acquired was determined with reference to an engineering report prepared by third party reserve evaluators using proved developed producing royalty reserves discounted at approximately 5%. The value attributed to the exploration and evaluation assets was determined with consideration of future development potential for the heavy and thermal oil project on which the acquired Company held an overriding royalty interest ( GORR ). The goodwill is attributed to the upside potential in the lands from future phases in a long life heavy and thermal oil project. The 2016 Corporate Acquisition is consistent with PrairieSky s strategy of seeking additional petroleum and natural gas royalty assets that are near term accretive to shareholders along with adding medium to long-term value enhancement potential through all commodity cycles. Transaction costs of $0.1 million are included in 2016 administrative expenses. From the date of acquisition, November 17, 2016, to December 31, 2016, approximately $0.3 million of revenue and approximately $0.2 million of net income were recognized. If the 2016 Corporate Acquisition had been effective on January 1, 2016, management estimates that pro forma revenue and pro forma net income for the year ended December 31, 2016 would have been approximately $225.7 million and $20.5 million, respectively. The pro-forma information disclosed is not necessarily indicative of the actual results that would have been achieved had the business combination closed on January 1, PrairieSky Royalty Ltd

16 6. ROYALTY ASSETS, NET December 31, 2017 December 31, 2016 Cost Balance, Beginning of Year $ 1,141.2 $ 1,039.7 Assets acquired through business combination (Note 5) Other asset acquisitions Transfers from exploration & evaluation assets (Note 7) Balance, End of Year 1, ,141.2 Accumulated Depletion, Depreciation and Amortization Balance, Beginning of Year (283.6) (121.1) Depletion, depreciation and amortization (166.7) (162.5) Balance, End of Year (450.3) (283.6) Net Book Value, End of Year $ $ For the year ended December 31, 2017, royalty assets acquired totaled $59.3 million ( $65.8 million) which are primarily acquisitions of fee land and various producing gross overriding royalties. Acquisitions included a gross overriding royalty on the SAGD thermal oil project at Lindbergh, Alberta (the Lindbergh Acquisition ) for $34.7 million and $23.0 million of producing royalty assets on fee lands and gross overriding royalty interests. During the year, the Company provided a lease amendment in exchange for royalty assets valued at $1.0 million and received a GORR in exchange for administrative expenses valued at $1.0 million (before cash closing adjustments of $0.4 million), both of which are included in the $59.3 million noted in the table above. During the year ended December 31, 2016, the Company acquired $65.8 million in royalty assets, which primarily included the 2016 Corporate Acquisition as well as acquisitions of producing gross overriding royalties. There was a non-monetary acquisition of fee lands valued at $0.2 million during the year ended December 31, EXPLORATION AND EVALUATION ASSETS December 31, 2017 December 31, 2016 Cost Balance, Beginning of Year $ 1,185.5 $ 1,148.4 Assets acquired through business combination (Note 5) Other asset acquisitions Transfers to royalty assets (70.0) (35.7) Land expiries (4.9) (6.2) Balance, End of Year $ 1,431.8 $ 1,185.5 For the year ended December 31, 2017, the Company acquired $321.2 million ( $79.0 million) in E&E assets which primarily included $215.2 million of value attributed to undeveloped drilling locations on current and future phases of the Lindbergh Acquisition, seismic, and undeveloped land acquisitions. A $15.0 million deposit paid in December 2016 was used to fund a portion of the Lindbergh Acquisition purchase price. Included in E&E assets is $54.9 million related to the acquisition of gross overriding royalty interests on emerging oil plays, as well as $35.3 million of gross overriding royalty interests acquired on non-producing assets, additional seismic and land acquisitions. PrairieSky Royalty Ltd

17 During the year ended December 31, 2017, the Company also acquired a non-producing GORR in exchange for 53,616 common shares valued at $1.6 million and provided a lease amendment in exchange for exploration and evaluation assets valued at $14.2 million. For the year ended December 31, 2016, the Company acquired $79.0 million in E&E assets, which primarily included the 2016 Corporate Acquisition, a gross overriding royalty on a thermal oil play in Onion Lake, Saskatchewan and seismic and land acquisitions. 8. GOODWILL Goodwill is assessed for impairment at least annually. The recoverable amount of the Company s sole CGU was determined using fair value less costs of disposal with reference to the market capitalization of the Company. The impairment test of goodwill at December 31, 2017 concluded that the estimated recoverable amount exceeded the carrying amount of the CGU, including goodwill. As such, no goodwill impairment existed. At December 31, 2017, the market capitalization of the Company was $7.6 billion. Goodwill December 31, 2017 December 31, 2016 Balance, Beginning of Year $ $ Acquired in the 2016 Corporate Acquisition (Note 5) Balance, End of Year $ $ ACCOUNTS PAYABLE AND ACCRUED LIABILITIES December 31, 2017 December 31, 2016 Trade payables $ 1.7 $ 2.9 Production and mineral taxes payable Accrued liabilities for cash settled share-based compensation Other accrued liabilities $ 17.0 $ SHARE CAPITAL AUTHORIZED The authorized share capital of the Company includes an unlimited number of common shares and an unlimited number of preferred shares issuable in series. The holders of the common shares are entitled to one vote in respect of each common share held at all meetings of shareholders, except meetings at which only holders of a specified class of share have the right to vote. The common shares have no par value. PrairieSky Royalty Ltd

18 ISSUED AND OUTSTANDING December 31, 2017 Number of Shares (millions) Amount ($ millions) December 31, 2016 Number of Shares (millions) Amount ($ millions) Common Shares Outstanding, Beginning of Year $ 3, $ 3,067.8 Issued pursuant to bought deal offering Share issue costs (net of $3.2 million tax effect in 2017) - (8.8) Issued pursuant to stock option plan (net of withholding tax) Issued pursuant to an acquisition (Note 7) Issued pursuant to dividend reinvestment plan Issued pursuant to stock dividend program Common shares repurchased (1.4) (19.8) (1.0) (13.0) Common Shares Outstanding, End of Year $ 3, $ 3,071.2 COMMON SHARES On January 6, 2017, the Company completed a bought deal prospectus offering of common shares. Pursuant to the offering, the Company issued 9.2 million common shares, including 1.2 million common shares issued pursuant to the exercise in full of the over-allotment option granted to the underwriters at a price of $31.40 per common share for aggregate gross proceeds of $288.9 million and net proceeds, after fees and expenses, of $276.9 million. NORMAL COURSE ISSUER BID ( NCIB ) On May 2, 2017, the Company announced the approval of the renewal of its NCIB by the TSX. The NCIB allows the Company to purchase for cancellation up to a maximum of 1,600,000 common shares over a twelve-month period which commenced on May 4, 2017 and expires no later than May 3, PrairieSky intends to allocate up to $44.0 million to repurchase common shares under the NCIB over such twelvemonth period. Purchases will be made on the open market through the TSX or alternative platforms at the market price of such common shares. All common shares purchased under the NCIB are cancelled. During the year ended December 31, 2017, the Company purchased for cancellation 1,402,300 common shares (December 31, ,000 common shares) at an average cost of $30.09 per common share (December 31, $27.04 per common share) for total consideration of $42.2 million (December 31, $26.0 million). The total cost paid, including commissions and fees, was first charged to share capital to the extent of the average carrying value of the common shares purchased and the excess of $22.4 million (December 31, $13.0 million) was charged to the deficit for the year. DIVIDENDS During the year ended December 31, 2017, PrairieSky declared dividends of $176.2 million (December 31, $186.7 million) or $ per common share (December 31, $ ) and paid dividends of $175.2 million (December 31, $197.7 million) or $ per common share (December 31, $ ). During the year ended December 31, 2017, all dividends were paid in cash. For the year ended December 31, 2016, $181.5 million was settled in cash and an additional $16.2 million was settled in common shares in lieu of cash dividends under the dividend reinvestment plan ( DRIP ) and stock dividend plan ( SDP ). The DRIP and the SDP were cancelled effective for the March 31, 2016 record date. On February 27, 2017, the Company increased its annual dividend by $0.03 per common share to $0.75 per common share per annum, effective for the March 31, 2017 record date. On December 14, 2017, the Board of Directors declared a dividend of $ per common share or $14.7 million payable on January 15, 2018 to common shareholders of record on December 29, PrairieSky Royalty Ltd

19 EARNINGS PER COMMON SHARE The following table presents the computation of net earnings per common share: Year ended December Net Earnings $ $ 20.0 Number of Common Shares: Weighted Average Common Shares Outstanding - Basic Effect of Dilutive Securities Weighted Average Common Shares Outstanding - Diluted Net Earnings per Common Share - Basic and Diluted $ 0.51 $ SHARE-BASED COMPENSATION PLANS The Company has a number of share-based compensation arrangements under which the Company awards various types of long-term incentive grants to eligible employees, officers and directors. They include stock options, PSUs, RSUs, and DSUs. The Company accounts for stock options granted to Company employees and officers as equity-settled share-based payment transactions and accrues compensation costs over the vesting period based on the fair values determined at the grant date. The Company accounts for its share unit awards, PSUs, RSUs and DSUs, held by Company employees, officers and directors as cash-settled share-based payment transactions and accrues compensation costs and dividends over the vesting period based on the fair value at each reporting date. The Company may make an election to settle vested share unit awards with either a cash payment equal to the five-day weighted average trading price for the common shares multiplied by the number of common shares or issue the number of common shares. PSUs vest following the completion of a three-year performance period provided the officer remains actively employed with the Company on the vesting date. RSUs granted to employees at the time of the IPO on May 29, 2014, vested 30% after the second anniversary of the date of grant and the remaining 70% vested after the third anniversary. All IPO grants vested in Subsequent grants vest evenly over a three year period, provided the employee remains actively employed with the Company on the vesting date. RSUs granted to officers vest evenly over a two or three year period provided the officer remains actively employed with the Company on the vesting date. DSUs are fully vested as of the grant date. The Company has recognized the following share-based compensation costs: Year ended December Compensation costs of transactions classified as equity-settled $ 1.8 $ 1.2 Compensation costs of transactions classified as cash-settled Total share-based compensation expense $ 9.8 $ 10.2 PrairieSky Royalty Ltd